ECB: Financial System Stress Back to Pre-crisis Levels

Financial sector stress in the eurozone has returned to the levels that prevailed before the global financial crisis got underway in 2007, according to the European Central Bank (ECB).

However, in its semi-annual Financial Stability Review (FSR), the ECB also cautioned that risks to the eurozone’s financial system from outside the currency bloc have increased since the US Federal Reserve began hinting over the summer of tapering its bond purchases.

The FSR cites the key risks to eurozone financial stability as economic and financial shocks, tensions in government debt markets, global financial market turbulence and bank funding challenges in the eurozone periphery. However “indicators measuring systemic stress have fallen back to close to their pre-crisis levels,” the report notes.

“Stress indicators and euro area fundamentals suggest alleviation of financial market tensions, especially on the banks’ funding side.”

Outside the eurozone, the ECB comments: “Starting in May, there was a significant repricing in global bond markets, which took place largely because of changing monetary policy expectations in the United States – with increased foreign exchange market volatility and stress borne largely by emerging market economies.”

This recent turbulence “might be a harbinger of further realignment of risk premia with fundamentals in bond markets” and that supervisors needed to ensure banks, insurers and pension funds could cope with a ‘normalisation’ of yields from their current historically low levels.

Data published separately on the ECB’s website showed that the systemic stress indicator hit in late September its lowest level in the euro era and has remained close to those levels since. However, with a crunch period of bank funding approaching, risks of banks cutting their balance sheets are increasing.

“With sizeable amounts of bank debt maturing over the coming months, persistently high funding costs for a set of challenged banks could amplify pressures for deleveraging of a disorderly nature – with an associated negative impact on economic welfare and growth,” the ECB warns.

Unforeseen bank recapitalisations could undermine stability. “Although provisioning is increasing, it has barely kept pace with the deterioration in asset quality, on average, highlighting a potential further need for additional reserves to strengthen bank balance sheet resilience in case asset quality deteriorates further.”

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